Russell 2000 Still Calls the Shots

In my last column, I again made a fuss about the Russell 2000, explaining that it was this index, rather than the Dow Jones Industrials or S&P 500 or Nasdaq, that seemed to be calling every turn of the market. Well, it called another turn -- this time the bottom on Friday -- prior to the sharp pop out of there, and now we're already back to new multi-month highs across the board.

Let's look at the recent action.

As noted in Thursday's column, last Wednesday's top was telegraphed by the Russell 2000's failure to go a penny above the morning highs (after filling that gap from Oct. 19 at 837.12). It topped out on Wednesday morning at 837.29 and couldn't move any higher despite higher highs in the Dow and S&P 500 following the Federal Reserve announcement. That was the kiss of death for the market, at least for the short term. And so the market sold off. At the lows on Friday, the Dow had plunged more than 200 points from Wednesday's highs. And again, the Russell signaled a turn, this time a bottom. Here's how.

It was the mirror image of Wednesday's pattern, in which the Russell 2000 failed to make a higher high with the other averages. That, of course, marked the top. This time, the Russell 2000 refused to make a lower low with the other averages that headed south late in the day. That marked the bottom. In fact, on Friday, the Russell 2000 bottomed in the first couple of minutes of trading at 821.82, just pennies below Monday's gap at 822.27. Recall, in Thursday's column I cited that gap as a target, noting that the Russell had just filled that gap, late Thursday. From there it bounced a bit into the close and then Friday morning pulled back to a fractionally lower low on the opening, and that was it. The Russell 2000 never went a penny lower, despite lower lows in the other averages.

In the short-term chart below you can see how, late in the day on Friday, it held just above the morning lows. Monday it gapped up and remained firm throughout the session. This morning saw another gap up opening and in the first few minutes of trading, the Russell 2000 had already exceeded last week's highs. Only the Russell 2000 was at new highs in the first few minutes of trading. Nothing else was close. But that told us that the rest of the market would soon follow.The S&P 500 made an early high of 1433.86, which was almost 5 points shy of last week's high. From there, as you can see on the short-term chart, it backed off toward its opening gap, but didn't quite fill it. A bit later, about an hour into the session, the S&P 500 joined the Russell 2000 in making a new multi-month high.

As you can see in the chart of the S&P 500, that recent high at 1438.59 has now been exceeded. So now what? Does the market just keep going higher forever now that there are apparently no more worries about the fiscal cliff? I doubt it.

There are still some overhead objectives for the S&P 500, notably the remaining overhead gap from Oct. 19 at 1457.76. That's a spot where I will do some selling, if we get there. Then, if that level is exceeded, there is the prior high of 1474.51, another spot where I will be taking profits.But the big story continues to be about the Russell 2000. I'm still holding positions in the RUT, though I cut back in my exposure last Wednesday morning at the 835 level. Though, as suggested in Thursday's column, I didn't re-establish those positions on the subsequent pullback. Instead I used the selloff in Apple (AAPL) to add to my positions in the Nasdaq-100. That's working out fine as it is popping.

But I will continue to keep close watch on the Russell 2000 and plan to do further selling, possibly on a return to the vicinity of its double-top highs at 868.50 or maybe before that, if it appears to be stalling. For now, with the January effect supporting this segment of the market, I am willing to stick with it a bit longer.The market wasn't overbought yesterday, at least not according to the McClellan Oscillator, which settled on the overbought side of neural at +39. But will likely be overbought at today's close (back above +100). Sentiment is also getting a bit frothy as the VIX trades in the 15 area.

None of this is good news. But, the seasonal pattern still has its best days ahead as the Santa Claus Rally kicks in this Friday and carries into the beginning of the new year. So I will maintain a decent bullish exposure to the market -- currently up to a maximum exposure of 45% invested -- though selling into resistance and buying dips, as usual.

At the time of publication, Schiller was long S&P 500, Nasdaq 100, Russell 2000, and high-yield bond funds at Rydex up to 45% levels; long junk bond funds at Fidelity up to 20% levels; holding bullish short puts in the IWM, QQQ and SPY. Long DIA calls and call spreads. Holding bullish January and February (put) credit spreads in AAPL.